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A hypothesis test for the long-term calibration in rating systems with overlapping time windows

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  • Patrick Kurth
  • Max Nendel
  • Jan Streicher

Abstract

We present a statistical test that can be used to verify supervisory requirements concerning overlapping time windows for the long-term calibration in rating systems. In a first step, we show that the long-run default rate is approximately normally distributed with respect to random effects in default realization. We then perform a detailed analysis of the correlation effects caused by the overlapping time windows and solve the problem of an unknown distribution of default probabilities for the long-run default rate. In this context, we present several methods for a conservative calibration test that can deal with the unknown variance in the test statistic. We present a test for individual rating grades, and then pass to the portfolio level by suitably adapting the test statistic. We conclude with comparative statics analysing the effect of persisting customers and the number of customers per reference date.

Suggested Citation

  • Patrick Kurth & Max Nendel & Jan Streicher, 2023. "A hypothesis test for the long-term calibration in rating systems with overlapping time windows," Papers 2312.14765, arXiv.org.
    • Handle: RePEc:arx:papers:2312.14765
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    References listed on IDEAS

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    1. Zhou, Chunsheng, 2001. "An Analysis of Default Correlations and Multiple Defaults," The Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 555-576.
    2. Sauer, Stephan & Coppens, François & Mayer, Manuel & Millischer, Laurent & Resch, Florian & Schulze, Klaas, 2016. "Advances in multivariate back-testing for credit risk underestimation," Working Paper Series 1885, European Central Bank.
    3. Weiping Li, 2016. "Probability of Default and Default Correlations," JRFM, MDPI, vol. 9(3), pages 1-19, July.
    4. Dirk Tasche, 2003. "A traffic lights approach to PD validation," Papers cond-mat/0305038, arXiv.org.
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